We love small businesses. They're creative, flexible, personable.
They are often the source of neighborhood pride. And a neighborhood's vibe.
But they also don't grow in value very much because of their size.
Companies that remain below $1 million in revenue struggle to get much more than 2x-3x "Seller Discretionary Earnings" (total of annual economic benefits to ownership) when they sell their business.
And that is if they can sell it all. If they've managed to remove themselves from critical roles and company dependency on their skills and contacts. If they have managed to put a team in place that can run the business without them.
These small business owners who can sell will often have to wait on a portion of the proceeds, in the form of a Seller's Note, so unsure is the buyer of the value they are getting.
And it all comes back to the risks inherent in being small. It doesn't take as much adversity or change to crater a small business. A big customer, key employee, or key supplier that is lost can mean the difference between succeeding and failing.
But those businesses that move past their founder's skills and input, and grow to multi-million dollar businesses with diverse employee and customer bases will sell for 4x-8x Seller Discretionary Earnings.
A quick example shows the powerful impact increased business size has on business value. A smaller business reporting $250,000 in Seller Discretionary Earnings would in most cases be valued by a potential buyer at 2x-3x those earnings, so between $500,000-$750,000.
A larger version of that business, with annual Seller Discretionary Earnings of $500,000, would likely sell for 3.5x-4.0x those earnings, between $1.75 million - $2.0 million. So while earnings have merely doubled in the example, and increased in absolute dollars by $250,000, the value of the business more than tripled. And the increase in absolute dollars on business value would be as much as $1.25 million.
This is the basis of the "roll up acquisition" strategy pursued by larger companies in all industries. We think of venture capital firms and Wall Street when we hear M&A, and roll-up acquisition strategy. But the concept is the same and as effective for the small business owner looking for growth. You buy or merge with a smaller business where you both are valued at a multiple of 2.0x-2.5x earnings, but together those combined earnings are worth a multiple of 3.5x or more.
With many small business owners looking to sell their companies in the coming years, it may be the perfect time for your business to acquire that critical scale and accelerate your business growth through acquisition.
We partner with business owners to help them confidentially approach acquisition targets, pursue terms of a deal, and manage Due Diligence efforts. Talk to us if you would like to start a business acquisition engagement.